Peso Plunges 6%; Investors Fear ‘Stagflation’ : Mexico: Bad financial news and political tensions trigger trading panic, pulling Bolsa index down as much as 3.4%.

A sudden speculative attack hit the Mexican currency Thursday, sending traders into a frenzy and knocking the peso down more than 6% to its lowest level in seven months in a selloff prompted by bad financial news and political tensions.

“There is no support for the peso right now; this is sheer panic,” a harried currency dealer said.

Investor anxiety over the currency’s erosion also sent tremors through the stock market, where prices fell sharply and pulled down the key Mexican Bolsa index by 3.4% before it bounced back, closing down less than 1%.

The nervousness also spread north to Wall Street, where the Dow Jones industrial average dropped 49.86 points to 4,703.82.

Wild rumors swept trading floors, but analysts said one basic fear haunted investors: Instead of a long-awaited recovery, Mexico’s recession-struck economy may be mired in an economist’s nightmare known as “stagflation.”

Fanning the panic was a new threat of unrest in the troubled southern state of Chiapas, after Zapatista rebels threatened to pull out of peace talks following the jailing of one of their founders in Mexico City last weekend.

The currency closed at a rate of 7.235 pesos to the dollar, worsening from Wednesday’s close of 6.785. It was one of the peso’s worst one-day drops since its devaluation last December, when it stood at a high of 3.45 to the dollar.

The peso’s lowest close ever was 7.45 to the dollar on March 9, a few hours before the United States and other lenders announced an emergency support plan.

The peso’s drop Thursday underscores how much doubt remains about Mexico’s future, despite a $20-billion bailout earlier this year from the U.S. government and bold predictions from President Clinton this month that Mexico’s economy had “turned the corner.”

“There is this chronic sense of lack of direction,” said Felix Boni, head of analysis at James Capel in Mexico. “The market is not buying into the idea that the [Mexican] economy by itself is going to generate growth again.”

President Ernesto Zedillo held a three-hour meeting with business leaders to discuss the financial turmoil, but they came up with no immediate solutions, the business community said.

Zedillo’s government has insisted with a drum-like regularity recently that Mexico’s recession has bottomed out and that unemployment--now at record levels--may be on the wane.

Bolstering its claim, the Social Security Institute issued an upbeat report Thursday saying the number of full-time workers jumped by 28,803 in the first half of October, up from a 2,769 gain in September.

But that report appeared to fall on deaf ears as investors worried that any incipient upswing in economic growth may be choked off by higher interest rates needed to defend the peso.

Rates on Mexican Treasury bills, or cetes, soared 16 percentage points to 53% in secondary market trading Thursday. Real interest rates are already at their highest point this year.

Analysts warned that higher rates could push the economy deeper into recession. The falling peso makes imports more expensive, fanning inflation that is already tugging in an upward direction, they said.

“I think stagflation is a concern,” said Jay Pelosky, director of Latin American strategy at Morgan Stanley in New York, referring to the mix of stagnation and inflation that the Mexican government has sought to avoid at all costs this year while trying to pull the country out of crisis.

* DOW OFF 49: U.S. stocks suffer their worst one-day decline in more than three months. D3